COVID-19 Vaccine Prospects and Curve Flattening Compel Cyclical Rotation

  • Sell gold and precious metals like GLD, GDX and SLV.
  • Sell Big Tech like AMZN, AAPL, FB, GOOGL and MSFT.
  • Pivot investments for an economic rebound and pandemic ending.
    • COVID-19 case rate is flattening.
    • 6 COVID-19 vaccines could be ready by year end.
  • Massive Fed balance sheet expansion has created bubble price actions.
The COVID-19 pandemic and the resulting business lockdown has created historic market and economic volatility over the last year. These extreme conditions have provided rare investment opportunities to those investors who analyzed both valuations and market risks and then capitalized on rare security price anomalies. Twice, in the last year, Income Growth Advisors (IGA) successfully highlighted extreme conditions and recommended prudent reallocations to its clients and readers. Today, IGA again has identified extreme price action in precious metals and big tech, and are recommending reallocation to attractive value opportunities as the COVID-19 crisis approaches its inevitable end.

Timely Market Calls:

Both last August and September, Income Growth Advisors advised buying gold – in August “Investors should adjust their portfolios to emphasize gold and commodities and reduce their holdings of stocks and bonds.” Again, in September – “This could be a pivotal moment where Income Growth Advisors, LLC can help investors reduce their portfolio risks and influence future outcomes.

The current parabolic spikes in gold and technology investments again compel sober profit taking and rebalancing transactions. Gold and precious metal investments have appreciated around 50% in the last year and now should be reallocated to economically cyclical and unpopular investment opportunities.

Below is a chart of the gold ETF (GLD) over the last 13 months. In the 11 months since our letters: GLD – the SPDR Gold Trust – rose 35%, GDX – the Van Eck Gold Miners ETF – rose 55%, and SLV – the iShares Silver Trust – rose 55%. (Period from Sept 9th, 2019 to August 7th, 2020.)

Likewise, we suggest trimming exposure to large cap technology stocks like Apple (AAPL), Amazon.com (AMZN), Facebook (FB), Alphabet (GOOGL) and Microsoft (MSFT) which have also risen parabolically. Many technology companies were COVID-19 business beneficiaries as their growth was largely unaffected by the lockdown, while traditional businesses suffered due to their sensitivity to economic contractions.
Source: Berkshire Asset Management.

The COVID-19 curve is bending, again:

The deceleration in COVID-19 cases correlates with reducing the chance of government-mandated business lockdowns which stop economic growth. The COVID-19 business lockdowns have hit cyclical, industrial and energy industries particularly hard.In the John’s Hopkins University chart below, the COVID-19 case count, the US [green line] turns lower from April until June. From June to August, cyclical stalled while large-cap tech continued higher due to the second wave of COVID-19 cases and massive central bank accommodation.

Source: https://coronavirus.jhu.edu/data/new-cases

With COVID-19 case growth declining, economically sensitive small cap, value, cyclical, industrial and energy business investments will outperform while gold and technology consolidate their parabolic price moves.

The development of one or several vaccines will absolutely reverse the economic damage of the COVID-19 pandemic. Within the next five months at least one of 7 new vaccine drug candidates should receive FDA approval based on successful phase three clinical trials which demonstrate statistically significant results in large double blind studies. As the result, the economic prospects for the world will dramatically improve. Economically sensitive stocks will benefit from the vaccine driven elimination of COVID-19 and resulting economic recovery.

Buy Economically Sensitive Laggards:

The chart below of the S&P 500 (SPY), Russel 2000 (small cap RUT), Energy (XLE), Industrials (XLI), and Materials (XLB) shows these economically sensitive sectors weakened from June until August when the COVID-19 case rate was reaccelerating. We are rotating into small cap, energy, industrial and materials, now that US COVID-19 case rates are again topping. This inevitable event will drive a reversion to the mean for cyclicals and growth stocks. Further, the pandemic’s inevitable end will taper the Federal Reserve’s unprecedented balance sheet expansion and undermine today’s euphoric demand for precious metals.

Fade Large Cap Technology:

The Covid-19 corollary is that the five largest tech companies – whose businesses were immune to government-imposed shutdown risks – will underperform as COVID-19 cases decline and vaccine prospects grow imminent. AAPL, AMZN, FB, GOOGL, and MSFT, are now overbought and should be sold to buy undervalued economically sensitive industries like energy, industrials and materials and the small cap and value sectors.

Energy Picks Past and Present:

From late March to May we wrote five letters recommending Kayne Anderson funds KYN and KMFMLPs, as well as Antero Resources Corporation (AR) and Antero Midstream Corporation (AM). These recommendations have all performed exceptionally well.

Buying into panic and chaos is never easy; however, Income Growth Advisors chronicled the Double Black Swans – COVID-19 and the OPEC+ oil collapse – which led to negative oil prices and rare extreme undervaluations for energy stocks. Those who followed our recommendations based on those extreme prices benefited significantly by acquiring those assets at extraordinary undervaluations.

Leveraged midstream closed-end Kayne Anderson funds:

KYN and KMF suffered a third price assault because the Double Black Swans led to margin calls. This Triple Black Swan culminated in a feedback loop of selling where forced liquidations reinforced panicked selling in the normally stable midstream energy Master Limited Partnership sector. Neuberger Berman’s MLP analyst Douglas Rachlin described the sell-off as a 10 standard deviation event. Those sober investors who heeded our recommendations enjoyed stellar returns until the summer resurgence of COVID-19 cases cooled the sector.
As of Aug 7th, 2020:
  • Kayne Anderson MLP/Midstream Investment Company KYN closed at $5.10/share with a $6.51 net asset value [21.6% discount to NAV] and a yield of 11.7%.
  • Kayne Anderson Midstream/Energy Fund KMF closed at $4.62/share with a $6.42/share net asset value [28% discount to NAV] and a yield 7.7%.
We continue to like both Kayne Anderson Funds closed-end funds KYN and KMF, but, investors should understand their inherent leverage is a double-edged sword. Both KYN and KMF have changed their mandates to emphasize more natural gas, ESG and renewable energy investments. These mandates have been board approved and will become effective on or about September 28th, 2020. This increased clean energy focus should drive smaller discounts to net asset value and increase investor demand for both funds. The Kayne Anderson portfolio transition is not a dramatic change, rather, it is a reflection of the changing energy market where carbon generating businesses are being outmoded.
MLPs continue to be undervalued. The chart below shows that the yield spreads for MLPs remain historically high. As such, a double for the sector is possible as MLP yield spreads revert to their mean of under 5% from its current 11.46% yield.

Antero Midstream (AM) and Antero Resources (AR) are our favorite stock investments in the energy space. Both companies are natural gas leaders who are beating expectations, buying their own stock, and enjoying an improving natural gas pricing environment after years of declining prices. We believe Antero Midstream will maintain their $0.3075 quarterly dividend or 17.9% dividend yield. Antero Resources has some risk from debt maturing in 2021; however, as we expected, $531 million in sales – more than half their targeted $750 million to $1 billion in asset sales – have been consummated and the company balance sheet continues to strengthen. We anticipate similar restructurings and are confident that this credit risk will be effectively eliminated because the company has been buying their own shares in the open market.

Antero Midstream was even selected by Ari Wald, CFA, CMT of Oppenhiemer who highlighted it in his August 8th, 2020 report which was advocating small cap stocks with momentum. We like when technical and fundamentals are both positive. We see AM rising to $13/share and AR to $20/share over the next 18 months.

Election Risk and Probabilities:

Market risks remain. Stocks and bonds are both expensive. Risks with China rise by the day. China has acted provocatively toward India, Hong Kong, and its neighbors which paints China as a serious economic and military force that increasingly looks like a potential instigator of World War Three.Presidential election uncertainty will keep capital sidelined until the election is called. Today, the probability of a Biden Presidential win is higher than that of a Trump win. The historic record is clear – the prospect of an incumbent winning is closely tied to the state of the economy. Since 1900, there have been ten elections when the incumbent had a strong economy and the incumbent won each time. In the six elections when the incumbent ran during an economic recession, the incumbent lost in all but one of those contests.

With the COVID-19 economic collapse, if the economy is not recovering strongly by November 3rd, Biden should win based on this economic history. However, the COVID-19 case rate appears to be peaking, and employment and GDP should enjoy positive growth heading into November. Conventional wisdom is that a Democratic White House or Senate will reverse the Trump tax cuts and corporate tax rates will rise from 21% to 28%. This would likely reverse the tax cut driven Trump rally hurting stock performance, though, historically markets have performed well under Democratic Administrations.

To conclude and reiterate, we recommend investors take profits in extended or parabolic investments and add to economically sensitive or undervalued investments. While this market has many real risks, great opportunities exist for those willing to do the research and act.

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The information expressed on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey and Income Growth Advisors, LLC

(IGA) cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose.

Nothing contained herein should be construed as a recommendation to buy or sell any securities.

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